Abstract
Sovereign borrowing during inflation surges is a litmus test of a government’s ability to withstand and navigate macroeconomic shocks. Based on transaction-level bond issuance data, we explore how sovereign financing strategies differ between surging and stable inflations and how policy practices affect their ability to weather inflation shocks. We find that governments lean more toward external borrowing in foreign currency during periods of high inflation, in part to reduce borrowing costs. This pattern is particularly prevalent in emerging markets (EMs), especially when the inflation surge is prolonged and severe. We further show that good practices of fiscal discipline and credibly pegged exchange rate regime alleviate external borrowing in foreign currency amid inflation surges.
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Notes
Argentina, an important player in international debt market, is missing from our sample because of the lack of data on control variables. Moreover, its inflation data from IMF is also relatively short (2007M1-2022M12), which prevent us from effectively identify the episode of high inflation.
Governments offer more credibility issuing foreign-currency bonds than inflation-linked bonds amid high inflation. This is because inflation-linked bonds carry the risk of governments potentially underreporting inflation rates, while foreign-currency bond values remain beyond a government's direct influence, ensuring a more transparent and reliable investment.
In similar manner, we show in columns 4 and 5 of Appendix Table 6 that further removing economy- and time-fixed effects change R-squared substantially, which justifies their inclusion.
We find similar insignificant difference (13 percentage points) between EMs with high and low foreign-currency external debt in their response to high inflation (p = 0.202).
The relative change in local-currency debt burden can be calculated as \(\frac{\frac{\mathrm{X}}{1+\uppi }-X}{\mathrm{X}}\approx -\) \(\uppi\). Similarly, approximation work for the relatively change in foreign-currency debt burden.
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Appendix
Appendix
See Fig.
Illustration of inflation surges and reversals in the US. This figure illustrates the time trend of the monthly inflation in the US. The gray and blue shaded areas highlight the episodes of inflation surges and reversals, respectively.
5 and Tables 8, 9, 10, 11, 12, 13, and 14.
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